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Does Microsoft Stand a Chance Against Google in Tablets?

Google's business model supports a presence on ultra-cheap tablets - but does Microsoft's?

Tablets based on Google's (NASDAQ:GOOGL) Android continue to gain share at a meteoric rate. This hardly comes as a surprise, as this platform has shown itself to be quite robust for both higher-end devices such as Google's Nexus 7 as well as lower-end devices such as the Dell Venue 7.

However, Microsoft's(NASDAQ:MSFT) Windows 8.1 -- particularly following the launch of a flurry of compelling Intel(NASDAQ:INTC) Atom-based 8-inch tablets from various OEMs -- seems to be gaining traction quite nicely. While at the high end, Microsoft's partners compete against both Google's partners and Apple(NASDAQ:AAPL). At the low end, Google's Android is the big hurdle. Can Microsoft succeed here or, more importantly, does it need to?

The fundamental issueMicrosoft depends on the sales of Windows licenses for the core of its consumer business to be successful. Google, on the other hand, makes money from users clicking on advertisers' sites on Google's own sites/services as well as partner sites. So, Google can essentially give away its Android platform as a vehicle to drive traffic and hopefully generate plenty of clicks. Microsoft, however, needs devices with paid Windows licenses to sell.

All three major mobile ecosystem vendors -- Google, Microsoft, and Apple -- generate revenue by taking a cut of the revenue generated from the sale of apps on their platforms. This generally amounts to peanuts, but it's nice to have the easy incremental revenue flow. At any rate, collecting 20-30% off of the sale of apps that typically sell for a dollar or two isn't enough to offset the loss of an operating system license sale.

This leads to Microsoft's dilemma. With Google's Android essentially free -- although, ironically enough, Microsoft does collect royalties on many of the Android devices out there today -- and with the OS so easily customizable by OEMs looking for every edge that they can get, how in the world does Microsoft compete in the high-volume segments of the tablet market?

Odds don't look good at the low endThe odds are very good that Windows 8.1/Windows RT won't be found running on a $70 tablet. Even if Microsoft were to charge just $5 for the OS on such a device -- and it's not clear that the bill of materials could support such a device and remain competitive -- the incremental revenue just wouldn't be that much for a company generating more than $80 billion a year in sales. It would not matter if Microsoft even took a huge amount of share in the market.

It is this realization that probably pushed Microsoft to begin to compete with its own OEM customers on building hardware for this space. But the hardware business is highly cutthroat, and the margins there for almost everybody will soon evaporate as they do in just about every consumer electronics market.

That being said, the real key to success here will be to find a way to drive unit growth in Windows licenses in more PC-like environments, where the strength of the full Windows 8.1 operating system will prove a meaningful competitive advantage -- and a value add -- over Android or iOS.

Convertibles and better PCs could do the trickAndroid is great for high-volume, low-cost tablets, while iOS services the high-end pure-tablet niche. But Microsoft Windows-based tablets -- particularly those 10 inches and larger -- can capture an interesting niche. As investors are seeing with devices such as the best-selling, $379 ASUS Transformer T100, which packs a low-power Intel processor and full Windows 8.1, there is a real demand for devices that can double as both tablets and traditional PCs.

On top of that, Intel's higher-end Core products will go into fanless designs next year, which could drive upside to demand in the higher end of the PC/convertible market -- a positive for Microsoft, which will get to collect full license fees from the sale of these systems. Any growth in the PC/higher-end tablet market is good for Microsoft as, once again, Android's capabilities simply don't compare once we get into the realm of more serious computing.

Foolish bottom lineWith only 25% of Microsoft's business coming from the sale of Windows licenses, it's tough to understand why Microsoft would care about the very low end of the tablet business. With compelling 8-inch designs at $299 and up, and with larger designs doubling nicely as tablets and PCs, Microsoft still owns the majority of the high-value portions of consumer computing. Sure, the business model doesn't work well on $70 devices, but -- as Apple has shown -- there's plenty of money to be made without having market-share leadership.

Author

Ashraf Eassa is a technology specialist with The Motley Fool. He writes mostly about technology stocks, but is especially interested in anything related to chips -- the semiconductor kind, that is. He can be reached on Twitter -- follow him there: Follow @tmfchipfool